Intel Inc is looking to acquire a new equipment for a project that will last ...
Intel Inc is looking to acquire a new equipment for a project that will last for eight years. The after-tax required rate of return of the project is 12% per annum. Intel can borrow at a before-tax interest rate of 10% per annum and buy the equipment outright or lease the equipment from ABC’s Leasing. The applicable corporate tax rate is 28% and the equipment will be fully depreciated to zero over the eight years using a straight-line method. Intel evaluated the lease and decided to buy the equipment by borrowing since the NPV of lease versus borrow-to-buy analysis was estimated to be -$10,000.However, subsequently Intel realised that in the analysis the purchase cost of the equipment had been under-estimated by $20,000, and also the salvage value of the equipment (at the end of the lease term) had been under-estimated by $7,000. Given the correct purchase price and salvage value, which of the following statements now accurately describes Intel’s decision regarding the acquisition of this equipment?-The equipment should now be leased since the additional cost saved is higher than the negative NPV calculated, i.e., NPV of lease versus borrow-to-buy is now $10,000.-None of the other answers is correct.-It is now indifferent between lease and borrow-to-buy.-The equipment should be leased since the NPV is now $3,000 after the inclusion of additional purchase cost and salvage value.-The equipment should still be purchased by borrowing since the NPV of lease versus borrow-to-buy is now -$2,666.20.static/image/hrline/1.gifStep 1 General Introduction
Explanation to lease or buy option :In the process of evaluating a lease or a buy decision, the cash flows of each option are discounted over the lease term to calculate their net present values and the option having higher net present values is selected. There are some relevant costs for both buying and leasing option which should be considered in making a decision.For lease option :
[*]Lease payments.
[*]Deposit payable at the beginning of the lease term and its return at the end of the lease term.
[*]Tax saving on lease payments.
For buying option :
[*]Purchase price.
[*]Residual or salvage value.
[*]Tax saving on depreciation deduction.
arrow_forwardStep 2 Solution
Net Present value of lease versus borrow-to-buy option-($10,000)
Purchase cot of the equipment under-estimated$20,000
Salvage value of the equipment under-estimated$7,000
After-tax required rate of return12%
Tax rate 28%
Term 8 years
Increase in Annual depreciation ($20,000 - $7,000)/8$1,625
Annual tax savings on depreciation $1,625 x 28%$455
Present value annuity (1-(1+0.12)-8)/0.124.9676397668
Net present value of buy vs lease$10,000
Present value of increase in purchase cost($20,000)
Present value of increase in salvage value $7,000/(1+0.12)8$2,827.1825958
Present value of tax savings on depreciation ($455 x 4.9676397668)$2,260.2760938
Net present value of buy vs lease ($10,000 + ($20,000) + $2,827.1825958 + $2,260.2760938)($4,912.5413104)
Correct answer - None of the other answers is correct.Explanation - As now the Net present value of lease vs buy option is positive, the equipment should be leased.
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